How to Determine the Value of Your First Business
It is a dilemma that many entrepreneurs face at some point during their careers: How do you assess the economic value of your company?
There are many ways to value your business. There is no “right” way, although you could probably think of several wrong ones. Ultimately, the business is worth what you think based on the criteria you set.
However, you can make an estimate by evaluating the company in different ways and then choosing the mix that reflects your final value estimation. You can start by looking at the value of the company’s assets: What does the company own? What equipment? What inventory?
Company valuation can, among other things, help you attract investors, set a fair price for employees, or grow or expand your business. Here are a few criteria to use to value your small business.
Entry Cost
This is a simple process. You simply find out how much it cost setting up an existing company similar to the one being valued? You have to take into account everything that has brought the business to where it is today.
Write down all start-up costs and then the property, plant and equipment. How much would it cost to develop products, build a customer base and recruit and train employees?
Then think about the savings you can make on set up. If you can save by moving the business to another location or using cheaper materials, subtract this from the estimate.
When you’ve considered everything, you have your entry costs – and a valuation.
Price to Earnings Ratio (P/E)
Companies are often valued based on their price-earnings ratio (P/E) or multiples of the profit. This model is suitable for companies that have a proven track record. Determining an appropriate P/E ratio may depend on profits. If a company has high forecast earnings growth, this may indicate a higher P/E ratio. And if a company makes good repeat profits, it may also have a higher P/E ratio.
For example, using a P/E ratio of four for a business that makes £500,000 post-tax profits means it would be valued at £2,000,000.
How you get the right figures for your P/E can vary significantly depending on the business. Tech startups often have a high P/E ratio, as they are usually high-growth companies. A more common high street company like a real estate agency has a lower P/E ratio and is likely to be a mature business.
Valuation of A Company’s Assets
Stable, established companies with many properties, plant and equipment, are often suitable to be valued on these assets. Real estate and manufacturing companies are good examples of such companies.
To perform an asset valuation, you first need to determine the transaction’s Net Book Value (NBV). These are the assets reported in the annual financial statements of the company.
Then you should think about the economic reality surrounding wealth. This essentially means that the figures are adjusted to the actual value of the assets. For example, the real values of old stocks are reduced. If there are debts that are unlikely to be paid, you can take them out. And property could have changed in value, so adjust those figures too.
Discounted Cash Flow
This is a complex method of evaluating a company based on assumptions about its future. The system is ideal for mature industries that have stable, predictable cash flows, such as electricity and telecommunications companies.
The discounted cash flow is calculated from the estimate of the future cash flow. You can get an estimate by applying a 15-year dividend forecast plus residual value at the end of the period. They measure the present value of each potential cash flow using a rate of discount, which reflects the risk and time value of the amount.
The time value of the money is based on the idea that £1 is worth more today than £1 tomorrow because of its earnings potential. Usually, the discount rate can be between 15 and 25%.
What works for one company does not always work for another. By giving you an overview of some common business valuation methods, we hope that you are closer to properly evaluating your first business.